McGraw-Hill/Irwin ©2009 The McGraw-Hill Companies, All Rights Reserved Chapter 15 The Role of Local Government

©2009 The McGraw-Hill Companies, All Rights Reserved15-2 What is the role of local government in the federal system? Why does voting with majority rule generate inefficient outcomes? Introduction: Questions to Address

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©2009 The McGraw-Hill Companies, All Rights Reserved15-5 Roles of Government: stabilization, income distribution, resource allocation Stabilization: Monetary & fiscal policy at national level Income distribution: Local efforts undermined by mobility of taxpayers and recipients Resource allocation by local government Provide local public goods Manage natural monopolies Internalize local externalities National versus Local Government

©2009 The McGraw-Hill Companies, All Rights Reserved15-6 Non-rival in consumption Non-excludable: impractical to exclude those who don’t pay Local: Benefits confined to small geographical area Characteristics of a Local Public Good

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©2009 The McGraw-Hill Companies, All Rights Reserved15-10 Each household chooses municipality with ideal level of local public good Perfect information and mobility No inter-jurisdictional spillovers No scale economies Head tax finances local public good Assumptions of Tiebout Model: Voting with Feet

©2009 The McGraw-Hill Companies, All Rights Reserved15-11 Example in Fig 15-1: Loisville (6 acres), Marianville (12), Hiramville (28) Evidence of Tiebout Sorting Los Angeles: communities are homogeneous w.r.t. demand Larger variation in demand means more municipalities National: Greater ethnic diversity means more decentralization Sorting: Demand for Local Public Goods

©2009 The McGraw-Hill Companies, All Rights Reserved15-12 Benefit Tax is proportional to private benefit of public good Practicalities Does government know marginal benefit of individual citizens? How roughly does benefit increase with income or property value? Benefit Taxation

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©2009 The McGraw-Hill Companies, All Rights Reserved15-14 Local Government and Natural Monopolies Natural monopoly: Increasing returns to scale large relative to demand Examples: Water, Sewer service, mass transit

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©2009 The McGraw-Hill Companies, All Rights Reserved15-16 Axiom 3: Externalities Cause Inefficiency Local governments respond to local externalities Chapter 8: Education externalities from team work, voting, crime reduction Chapter 10: automobile externalities Public provision is one response to externalities Local Government and Externalities

©2009 The McGraw-Hill Companies, All Rights Reserved15-17 Voucher (coupon) can be used to pay for education, public or private Schools qualify for vouchers by satisfying basic requirements Consequences of vouchers Competition fosters efficiency? Will peer environment of low-income students deteriorate? Education Vouchers

©2009 The McGraw-Hill Companies, All Rights Reserved15-18 Prevents income segregation that could occur with universal voucher Results Higher math test scores; no difference in reading scores Students in small public-school classes did just as well Benefits of vouchers from small class size? Will vouchers generate better teachers? Targeted Vouchers for Low-income Families

©2009 The McGraw-Hill Companies, All Rights Reserved15-19 Police and crime control Capturing externality: Everyone benefits when criminal captured Chasing externality: Others bear a cost when criminal flees Fire protection: Fires can spread Externalities from Public Safety Programs

©2009 The McGraw-Hill Companies, All Rights Reserved15-20 When is Local Provision Efficient? Diversity in demand: Large Externalities: Relatively small in geographical sense (within the jurisdiction) Scale economies: Relatively small Facts on Scale Economies Moderate scale economies in water and sewage service Other local public goods: scale economies exhausted at population = 100k Federalism and Metropolitan Government

©2009 The McGraw-Hill Companies, All Rights Reserved15-21 Interjurisdictional externalities large relative to diversity in demand Intergovernmental grants to subsidize local activities Manage metropolitan networks: highways, disposal, schools, airsheds, watersheds Metropolitan government: Portland, Minneapolis-St. Paul Rationale for Metropolitan Government

©2009 The McGraw-Hill Companies, All Rights Reserved15-22 A Closer Look at the Median-Voter Result Median voter is decisive; majority rule chooses preferences of median voter Does election format matter?

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©2009 The McGraw-Hill Companies, All Rights Reserved15-25 No reason to expect voting to generate socially efficient outcome To predict outcome of election, need preferences of median voter Use data to estimate elasticities of demand for local public goods Implications of the Median-Voter Result

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©2009 The McGraw-Hill Companies, All Rights Reserved15-27 Assumes away ideology: Politicians care only about winning elections Alternative: Politicians as opinion leaders rather than followers Assumes single issue: If many issues, candidates offer bundle of positions Assumes that everyone votes Indifference: Abstain if positions are close enough Alienation: Abstain if closest position far enough away from own If some citizens abstain, median voter won’t necessarily prevail Unrealistic Assumptions of the Median- Voter Model